The Federal Reserve’s decision on Thursday might indirectly hint that interest rates will not be raised this year, and many Fed watchers interpreted the decision specifically that way. The Dow Jones Industrial Average closed 290.16 points in the red on Friday, as equity market participants started to digest the freshly-announced decision on interest rates. However, many corporate executives were buying their company’s stock amid the turmoil in the financial markets, which was further fueled by the Fed’s decision. Viper Energy Partners LP (NASDAQ:VNOM) and McGraw Hill Financial Inc (NYSE:MHFI) had particularly strong insider buying activity during the last days of the previous trading week, and we will attempt to determine what reasons stand behind these insiders’ moves. Although insider buying can be perceived as a bullish sign, and studies have shown that imitating such moves has historically lead to a small outperformance of the market in the short-to-medium term, one should nonetheless conduct diligent research prior to imitating insiders’ moves, as not all trades are created equal.
Most investors can’t outperform the stock market by individually picking stocks because stock returns aren’t evenly distributed. A randomly picked stock has only a 35% to 45% chance (depending on the investment horizon) to outperform the market. There are a few exceptions, one of which is when it comes to purchases made by corporate insiders. Academic research has shown that certain insider purchases historically outperformed the market by an average of seven percentage points per year. This effect is more pronounced in small-cap stocks. Another exception is the small-cap stock picks of hedge funds. Our research has shown that the 15 most popular small-cap stocks among hedge funds outperformed the market by nearly a percentage point per month between 1999 and 2012. We have been forward testing the performance of these stock picks since the end of August 2012 and they have returned 118% over the ensuing 36 months, outperforming the S&P 500 Index by over 60 percentage points (read the details here). The trick is focusing only on the best small-cap stock picks of funds, not their large-cap stock picks which are extensively covered by analysts and followed by almost everybody.
Let’s start out by taking a thorough look at the insider trading activity at Viper Energy Partners LP (NASDAQ:VNOM). Michael L. Hollis, Vice President, Chief Operating Officer and Director of Viper Energy, reported acquiring 3,000 shares on Thursday at a weighted average price of $15.80. These shares were purchased through multiple transactions at prices in the range of $15.44 to $15.95 per share. Hence, following these multiple transactions, the executive currently holds 56,580 shares. It is commonly believed that directors know less about a company’s outlook and prospects than executives, so executives’ buying activity might bear more useful information. The shares of Viper Energy have lost half of their value since the company’s IPO back in June 2014, primarily owing to the global oil glut. This year hasn’t turned out to be very good either, as the stock has dropped by nearly 12% year-to-date. Therefore, it might be the case that Michael Hollis is betting on a turnaround in the oil industry in the years ahead, an idea that is supported by a good deal of experts and analysts. To be more detailed, some believe that the oversupply in the oil market will take a year or two to fade away, while cuts to oil companies’ capital spending will eventually trigger an oil price bull market. Charles Davidson’s Wexford Capital is among the top shareholders of Viper Energy Partners LP (NASDAQ:VNOM) with 504,444 shares as of June 30.
